Computer Simulation in Financial Risk Management: A Guide for Business Planners and Strategists

Computer Simulation in Financial Risk Management: A Guide for Business Planners and Strategists

Synopsis

Computer programs that simulate complex processes in the real world can provide a quantitative tool for determining how much debt can be safely added to a company's capital structure. This book shows why current methods of risk management fail, and how computer simulation can be employed to determine a safe level of debt. Through actual examples the reader will learn how to use simulation techniques to quantify risk factors and to objectively incorporate both lender and borrower positions.

Excerpt

The management of risk is a contradiction in terms. Management implies control. Sales managers who decide to cut prices by 10 percent do so on the basis that they control those prices. They direct supervisors to lower the prices on goods by 10 percent. They manage price by virtue of the fact that they can come to a decision about price and then exert control over price by means of an instruction or by changing the price themselves. This is management, particularly if managers order someone else to go around the store marking down prices rather than doing it themselves.

Production managers determine the quantity of output in a factory. They review what has to be reviewed, meet, talk, discuss, contemplate, and act. They issue an instruction, orally or in writing, for production to be increased or decreased by a certain amount. Since they are controlling the output of the factory, they are deemed managers. Managers are managers by virtue of the fact that they exert control over situations.

Can we manage risk in the same way we determine prices on goods or the output of a factory? If the answer is affirmative, then the implication is that we have control over future events. and this is demonstratively not so. We have no control over future events, but simply do the best we can dealing with the unfathomable.

Yet we can take actions to reduce the chances of something terrible happening. For instance, if someone insists on driving over a wet, slippery mountain road in the midst of fog in the dead of the night with the accelerator pressed to the floor and the brakes disconnected, there is a certain risk of plunging over a cliff. If, on the other hand, the driver exercises a great deal of caution, there is certainly less risk of finding oneself in free fall. and if the driver waits for the sun to lift the fog and dry the road, there is an even greater chance of surviving the trip. Certainly, risk . . .